Last week’s The Economist leader and cover story, “Picking winners, saving losers”, painted an insidious picture of governments’ increasing intervention in market economies, arguing that the hideous Leviathan of the state was gobbling up one sector after another and warning that “picking industrial winners nearly always fails.” Now, put aside the fact that the government was forced into some sectors—such as automobiles and financial services—only after mammoth market failures and pleas for rescues from capitalism’s chieftains.  The more important fact is that the article feeds a Socialism-is-coming hysteria and ignores how picking winners—within limits—has worked in the past for the United States (and Japan, South Korea, etc.) and is needed more than ever to bolster our long-term competitiveness.

Of course, the debate about the appropriate role between the state and the private sector in market economies has raged for centuries. The debate is marred in part by vague terminology, and The Economist perpetuates this problem by throwing around a slew of terms—“picking winners”, “industrial policy”, “innovation policy”—without adequately distinguishing between them but while uniformly indicting them as inappropriate manifestations of government economic intervention.

It would be more constructive to envision a continuum of government-market engagement, increasing from left to right in four steps from a “laissez faire, leave it to the market” approach to “supporting factor conditions for innovation (such as education)” (which The Economist endorses, as, certainly, does ITIF) to going further by “supporting key technologies/industries” to at the most extreme “picking specific national champion companies”, that is, “picking winners.”  And while it is generally inadvisable for governments to intervene in markets to support specific national champion companies, ITIF believes there is an appropriate role for government in placing strategic bets to support potentially breakthrough nascent technologies and industries.

Ironically, The Economist asserts that, “Industrial policy may be designed to support or restructure old struggling sectors, such as steel or textiles, or to try to construct new industries, such as robotics or nanotechnology. Neither track has met with much success. Governments rarely evaluate the costs and benefits properly.” Yet, seconds later, the authors admit, “America can claim the most important industrial-policy successes, in the early development of the internet and Silicon Valley.” In one sentence, the article glosses over the point that the government, in this case the Defense Advanced Research Projects Agency (DARPA), “supported creation of ARPANET, the predecessor of the Internet, despite a lack of interest from the private sector.” (Italics mine.) But this point, as economists are wont to say, is “non-trivial.” In fact, it is the precisely the point.

Early on, companies were reticent to invest in the nascent field of computer networking because the sums required were enormous and the technology was so far from potential commercialization that companies were unable to foresee how to monetize potential investments. Moreover, such basic research often results in knowledge spillovers, meaning the company cannot capture all the benefits of its R&D investment (in economist’s terms, the social rate of return from R&D is higher than the private rate of return), and thus companies tend to underinvest in R&D to societally optimal levels. Of course, this dynamic pertained not just to the Internet, but applies today to a range of emerging infrastructure  technologies such as biotechnology, nanotechnology, robotics, etc. As Greg Tassey, Senior Economist at the National Institute of Standards and Technology (NIST), explains it, “the complex multidisciplinary basis for new technologies demands the availability of technology “platforms” before efficient applied R&D leading to commercial innovation can occur.” In other words, the levels of investment required to research and develop emerging technologies is so great that the private sector cannot support it alone, and thus, “government must increasingly assume the role of partner with industry in managing technology research projects.”

Such was the case with the initial development of the Internet, as government stepped in and provided initial R&D funding, helped coordinate research between the military, universities, and industry, and thus seeded development of a breakthrough digital infrastructure platform, making the Internet a reality decades before the free market ever would have (if ever) if left to its own devices. And this admittedly-successful industrial policy has indeed been a spectacular success. As ITIF documented in a recent report, The Internet Economy 25 Years After.com, the commercial Internet now adds $1.5 trillion to the global economy each year—that’s the equivalent of adding  South Korea’s entire economy annually.

Moreover, the list of technologies in which government funding or performance of research and development (R&D) has played a fundamental role in bringing the technology to realization is long and compelling. It includes: the cotton gin, the manufacturing assembly line, the microwave, the calculator, the transistor and semiconductor, the relational database, the laser beam, the graphical user interface, and the global positioning system (GPS), amongst many others. The National Institute of Health (NIH) practically created the biotechnology industry in this country. And yes, even Google, the Web search darling, isn’t a pure-bred creature of the free market; the search algorithm it uses was developed as part of the National Science Foundation (NSF)-funded Digital Library Initiative. (But Google hasn’t done much to spur economic growth!) The point is that companies like IBM, Google, Oracle, Akamai, Hewlett-Packard, and many others may not have even come into existence─and certainly would not have prospered to the extent they have─if the U.S. government was not either an early funder of R&D for the technologies they were developing or a leading procurer of the products they were producing. And if you don’t get Intel developing the semiconductors, or Cisco building out the Internet, or Akamai securing it, or Google making it accessible, then you don’t get the downstream companies like the Amazons or eBays, the latter of which 724,000 Americans rely on as their primary or secondary source of income.

Thus, while governments shouldn’t be creating and running such companies itself—that is for the free market to do—the government has a role to play in thoughtfully, strategically, and intentionally placing strategic bets on nascent and emerging technologies—as the United States did with information and communications technologies in the 1960s and 1970s—that have the potential to turn into the industries, companies, and jobs that drive an economy two to three decades hence. We call this innovation policy, as opposed to industrial policy. Today, this augurs the need for smart policies and investments in industries such as robotics, nanotechnology, clean energy, biotechnology, synthetic biology, high-performance computing, and digital platforms such as the smart grid, intelligent transportation systems, broadband, and Health IT. Explicit in this approach is a recognition that some technologies and industries are in fact more important than others in driving economic growth—that “$100 of potato chips does not equal $100 of computer chips.” Indeed, they are not because some industries, such as semiconductor microprocessors (computer chips) experience very rapid growth and reductions in cost, spark the development of subsequent industries, and increase the productivity of other sectors of the economy—not to mention support higher wage jobs.

Yet The Economist frets that governments aren’t very good at identifying and investing in strategic emerging technologies. In impugning governments’ ability to pick winning technologies, the article cites failures such as France’s Minitel (a case of a country picking a national champion company) and argues that “Even supposed masters of industrial policy {like Japan’s MITI, or Ministry of International Trade and Industry} have made embarrassing mistakes.” But this would be tantamount to pointing to the spectacular failure of Apple’s Newton and arguing that Apple’s no good at innovation. The Economist seems to suggest that if governments failed 80-90% of the time in picking technology winners (and ITIF actually thinks their success rates are much higher), then they must be pretty incompetent at the effort and should stop trying altogether.

But if private corporations followed that advice, then we would have no innovation whatsoever. Indeed, research by Larry Keeley of Doblin, Inc. finds that, in the corporate world, only 4 percent of innovation initiatives meet their internally defined success criteria. More than ninety percent of products fail in the first two years. Other research has found that only 8 percent of innovation projects exceed their expected return on investment, and only 12 percent their cost of capital. Yet companies have to continue to try to innovate, even in the face of these long odds, because research finds that firms that don’t replace at least 10 percent of their revenue stream annually are likely to be out of business within five years. The point is that just because innovation is difficult and success rates are low, this does not mean that corporations, or governments, should quit trying—or that their successes, like the Internet, can’t be spectacularly successful and have a profound impact on driving economic growth.

But The Economist laments that industrial or innovation policies are subject to capture by industries. What this neglects is that all countries, including the United States, already have de facto industrial policies that favor some industries over others. In the United States, for example, our regulatory and tax system favors agribusiness through farm subsidies, the oil industry through oil subsidies, airlines and highways at the expense of rail, and mortgage and financial industries. In fact, it is precisely because the United States has historically lacked an ability, or willingness, to have a clearly defined innovation strategy and an open dialogue about “making strategic decisions about strategic industries” that we’ve ended up with a de facto industrial policy ill-suited to supporting industries that will drive economic growth in the future. The Economist notes that “there is no accepted framework for “vertical” policy, favoring specific sectors or companies.” True. So let’s make one.

Finally, while The Economist criticizes President Obama’s new Strategy for American Innovation (released in 2009), it fails to come up with compelling evidence that breakthroughs such as mapping the human genome, unlocking nanotechnology’s potential, or achieving the technology-enabled transformations that need to occur in sectors from energy to transportation will occur solely because of the market’s ability to allocate capital efficiently. In this, it discounts the need for effective, intentional public-private partnerships to invest in and collaborate in the development and diffusion of these industries and technologies.

This critique is not meant to pick on The Economist, which is usually chock full of solid reporting and informed commentary. Rather it is take on the myth of America’s purely free market capitalist system and make the case for an informed innovation policy. It is also to note that countries (like the United States) find themselves desperately turning to industrial policy in a last ditch effort to save stumbling sectors such as automobiles because they have failed to make adequate investments in innovation policies that would support science and technology, R&D, and the development and diffusion of innovative processes and technologies that could have helped keep old sectors like automobiles at the technology frontier while supporting the development of new sectors to drive the economy forward.

Finally, it seeks to rebut the ideological and highly politicized assault on the idea the governments cannot make prudent, targeted bets on the industries of tomorrow. As Greg Tassey has noted, competition among governments has become a critical factor in determining global market share among nations. Indeed, the role of government is now a critical factor in determining which economies win and which lose in the increasingly intense process of creative destruction.

There are appropriate and inappropriate roles for governments to play in this competition. Supporting education, removing barriers to competition, supporting free and fair global trade, opening countries to high-skill immigration, and targeting strategic R&D investments towards the technologies and industries of the future are appropriate roles for governments to play in this competition. Other government policies, such as mercantilist ones which deny foreign countries’ corporations access to domestic markets, pilfer intellectual property by stealing it outright or making it a condition of market access, creating indigenous or proprietary IT standards, failing to adhere to trade agreements, or directly subsidizing domestic companies or their exports, are illegitimate forms of global economic competition. The United States—and The Economist—must abandon its fanciful, stylized neoclassical notion of a purely free global economic marketplace unfettered by any form of government intervention whatsoever, and recognize that governments play a legitimate and crucial role in shaping the innovation capabilities of national economies. As between corporations, it’s a competition; and, as with companies, the ones that develop the best strategies and skills at fostering, developing, and delivering innovation are the ones most likely to win.

Photo credit: chrismear’s photo stream

I wrote last week about the political rhetoric of “uncertainty,” both real and imagined.  My thinking was that Republicans should be called out for their recent talking points that attribute our continued economic woes to fears and uncertainties created by the Democrats’  agenda, but that we should be careful not to dismiss legitimate problems of uncertainty that actually do exist in the economy.

In the Times today, Tom Friedman makes a more eloquent case for the need to recognize the real uncertainties we face.  His analysis is from a higher altitude, as one might expect, and it is dead right.  Friedman attributes broad economic uncertainties to three structural problems: (1) a decade of U.S. growth fueled by deficits and borrowing rather than investment and innovation, (2) a wave of new technology that is destroying lower-skilled jobs in favor of those requiring more education and training, and (3) the “existential crisis” of the European Union as German discipline is exported to Greece and elsewhere.   But these real uncertainties are not on anyone’s political agenda:

America’s two big parties still cling to their core religious beliefs as if nothing has changed. Republicans try to undermine the president at every turn and offer their nostrum of tax-cuts-will-solve-everything — without ever specifying what services they’ll give up to pay for them. Mr. Obama gave us expanded health care before expanding the economic pie to sustain it.

Friedman does not get very deep into specifics for structural solutions, but he doesn’t need to.  As is often true of Friedman’s perspective, the real value of today’s piece lies in the diagnosis.  We are facing real economic uncertainties, and the fact that Republicans are mischaracterizing them so shamelessly does not relieve the president and Democrats from the obligation to show more leadership.  As I wrote last week, Democrats need to stop sticking their fingers in the dike and come up with a more comprehensive plan built on a long-term vision of investment and sustainable growth.  Or as Friedman puts it:

The president needs to take America’s labor, business and Congressional leadership up to Camp David and not come back without a grand bargain for taxes, trade promotion, energy, stimulus and budget cutting that offers the market some certainty that we are moving together — not just on a bailout but on an economic rebirth for the 21st century.

I couldn’t agree more.

I returned yesterday from an overseas vacation to find Washington embroiled in furious controversy over Robert Gibbs’s gibes at the “professional left.” Somehow, the shock waves from this momentous development had failed to register in Corsica, which may be a gorgeous, sun-splashed rock in the Mediterranean, but is hopelessly apathetic about U.S. politics.

Fortunately for slackers like me, Washington’s chattering class is too busy for vacations. And cable TV never rests, keeping the vital discourse of democracy going even as Americans frolic heedlessly on beaches, lakes and mountains. Well, the fun’s over for me, so I might as well wade into the fray between the frazzled White House Press Secretary and his netroots tormentors.

For starters, it’s hard not to feel some sympathy to Gibbs, for whom watching cable TV is an occupational hazard. Too much of a bad thing, is, well, bad and it’s only human for Gibbs to vent about the ideological purism of talk show anchors and lefty bloggers who imagine that most Americans are pining for a full-throated liberal avenger in the White House. Real-life politics is nothing like The West Wing.

And Democrats might as well have it out now, the summer of their economic discontent, rather than, say, in October on the eve of the midterm. One truly silly argument is that Gibb’s criticisms of the administration’s “base” could alienate them and cause them to stay home on election day. In the first place, netroots types aren’t really the Democratic Party’s base.

They are a subset of liberals, who are themselves outnumbered by moderates and conservatives in the party. And they love to be attacked, because it validates their rather inflated sense of political self-importance. The worst thing you can do to the netroots is to ignore them.

In fact, every Democratic President in recent memory has been flayed by the hard left for lapses from orthodoxy. That is especially true of Franklin Roosevelt, the President many of today’s disappointed liberals say they wish Obama would be more like.

Like Obama, FDR was called a tool of Wall Street, a trimmer, an opportunist. He was bitterly assailed for trying to rescue and restore the free enterprise system rather than replacing it with central economic planning.

This drove leading liberal New Dealers like Rexford Tugwell and Harold Ickes to distraction. Here’s Tugwell:

“They [FDR’s liberal critics] are like Chinese warriors who decide battles, not by fighting, but by desertion…They rush to the aid of any liberal victor, and then proceed to stab him in the back when he fails to perform the mental impossibility of subscribing unconditionally to their dozen or more conflicting principles.” (Schlesinger, The Politics of Upheaval, 414)

And Ickes had some equally choice words for the perfectabilian demands of his fellow liberals:

“That so-called liberals spend so much time trying to expose fellow liberals to the sneering scorn of those who delight to have their attention called to clay feet…I get very tired of the smug self-satisfaction, the holier-than-thou attitude, the sneering meticulousness of men and women with whose outlook on economic and social questions I often regretfully find myself in accord. It seems to be a fact that a reformer would rather hold up to ridicule another reformer because of some newly discovered fly speck than he would to clean out Tammany Hall. Sometimes even the fly speck is imaginary.” (Schlesinger, The Politics of Upheaval, 413-414)

Gibbs has a point when he says that liberals undervalue Obama’s major political achievements. On the big matters that really count – the breakthrough on universal health care, the financial regulatory bill, getting out of Iraq on time, and placing liberal women on the Supreme Court (including the Court’s first Hispanic member) – Obama unquestionably has moved the needle in a progressive direction. But if history is any guide, it won’t matter – he’s still going to get pilloried by the congenitally insatiable left for something (For failing to close Gitmo, or embrace gay marriage, or demand amnesty for immigrants, etc.)

The fundamental problem with the left’s carping about Obama is the underlying assumption that their views are shared by a majority of the country: If only he would fight harder for structural transformations in American life, the latent progressive majority would spring into being and rally behind him!

This is sheer fantasy. If the country has moved in any direction over the past two years, it is to the center, and perhaps even the center right (excepting Republicans, who have surged lemming-like off the ideological cliff). What liberals see as overly tepid moves to restructure and stimulate the economy a healthy chunk of the increasingly cranky electorate, especially independences, see as overweening government intrusion.

The party’s leftists are obviously within their rights to criticize Obama when they think he deviates from the true path, just as centrists and conservatives are. And the dialectic between the President’s essential political pragmatism and left-wing fundamentalists is probably a healthy thing. It could force Obama to articulate more clearly the overarching philosophical framework that informs a Presidency that otherwise seems to proceed on the logic of serial pragmatism.

But ultimately, left leaning Democrats aren’t going to find a better horse to ride. And the more they flog Obama, the worse Democrats are likely to do this November.

The Shed -- Dermott, Arkansas

Alexis de Tocqueville would understand “The Hacketts Gospel Singing Shed.”

Located in Dermott, Arkansas on the edge of a small cotton farm, “The Shed,” as locals call it, is a venue for gospel singers and fans to gather for song, worship, and fellowship. In the 1830s, Tocqueville toured America and witnessed the very sort of religiosity and voluntarism that motivated the Hackett family to transform a tractor shed into what has become a local community hub. The young Frenchman’s resulting sociological masterpiece, Democracy in America, explains “The Shed” and offers some timeless lessons about America’s uniquely ambitious political culture –
lessons Democrats looking for keys to ending the Great Recession ought to consider.

During his travels, Tocqueville recognized how republican ideals and cheap plentiful land had produced a profoundly optimistic, democratic, individualistic, entrepreneurial, and decidedly populist people. His shorthand for the differences between the U.S. and Western European political cultures – “American Exceptionalism”— remains a handy and useful concept progressives should both heed and employ.

“Exceptionalism” is not a Limbagh-esqe a priori verification of America’s supreme awesomeness. Rather, exceptionalism cuts both ways. The very populist impulses both bred the civil rights movement and spawned the Tea Party.

In the same way, American individualism is responsible for both a vibrant economic growth, a broad middle class, technological innovation, AND an anemic welfare state, concomitant high poverty and comparatively crime rates.

In sum, exceptionalism is not chest-thumpin’ We-Will-Rock-You, rah-rah USA cornpone; Tocqueville would recognize “The Hacketts Gospel Singing Shed” by echoing Denny Green’s infamous postgame rant, “They are who we thought they were!”

American Exceptionalism not only explains “The Shed.” It should also inform Democratic policy responses, both in substance and style, to the Great Recession.

Progressives understandably shy away from a term that seemingly reeks of parochialism and sounds like a potential first and middle name for one of Sarah Palin’s children. Instead of “exceptional” substitute “difference” and then wonder how and why Germans accept 8 percent unemployment as normal, middle class Danes ride bikes to work instead of drive cars, or Canadian cities are so neat-and-tidy. For better or for worse, the American “difference” is real.

Economic recoveries are like snowflakes—no two are ever the same. This should remind us that the “dismal science” is no hard science at all. To hear Paul Krugman or the Cato Institute’s certitude, however, one would hardly realize economists are making little more than highly educated guesses.

Ironically, even as partisan economists claim all-knowing prescience their field is thankfully moving away from technocratic certainty and toward ambiguity. While it is humbling (and quite a bit scary) to accept mysterious, unpredictable, and ultimately unknowable economic forces control our material fates, this is exactly why the American difference matters.

Modern progressive economic policy should combine short-term fiscal stimulus and long-term deficit reduction with rhetorical and policy faith in the American character. While sound policy matters, more and more economists realize that intangibles and emotions often spell the difference between recovery and double dip recessions.

The American difference really matters. Four hundred years of history (including the colonial era) proves that American optimism, individualism, entrepreneurial spirit, and waves of eager immigrants will eventually lead to robust economic recovery. Talk of decline, power moving east, and a new “normal” are reminiscent of the early 1990s when observers claimed Japan and Germany would overtake American economic leadership. If memory serves, the 1990s were fairly good economic times.

President Obama has provided such leadership. Time and again he has extolled the American work ethic and unique character; it is Congressional leaders and the liberal punditocracy, however, who are out of tune with the great resilience of the American tradition., Congressional leaders – who too often dwell myopically on technocratic details, medium versus big stimulus or extending unemployment benefits – fail to convey the most important ingredient for economic policy success: sunny optimism and a profound belief in an American difference.

All peoples in all lands hope, innovate, and work for a better future. Americans do so in their own unique, different, and yes even “exceptional” way. The route of this mess takes good policy but requires bold, optimistic, and a quintessentially American leadership. It is the sort of simple yet profound wisdom that a Frenchman; the folks of Dermott, Arkansas; and skinny kid with big ears and a funny name all know in their bones.

photo credit: Jeff Bloodworth